A:

Holding an option through the expiration date without selling does not automatically guarantee you profits, but it might limit your loss. For example, if you buy a call option for stock A, which currently trades at $90, a decision has to be made as to whether to exercise the option at its expiration date, sell the option or let the option expire. Let's say the stock price goes up to $100 and the option cost is $2. If a decision is made to exercise the option, then the profit that would be made is $100-$90-$2 = $8.

It is important to remember that some types of options permit the holder to exercise the option at specific times. An American-style option has no restriction. It can exercised at any time between the purchase date and the expiration date. A European-style option, however, can only be exercised at expiration and Bermuda options have specific periods when exercise is permitted.

If the decision is made to sell the option, then the profit made may be slightly higher. If the option is sold before expiration date, then implied volatility and the number of days remaining before expiration may increase the price of the option. Let's assume that the price is higher by 10 cents. The profit made will be $10.10 - $2 = $8.10. The decision to sell the option assumes that it is in the money. If the option is out of the money, then exercising the option makes no sense at all because money will be lost if the stock is sold on the market.

One scenario that calls for letting the option expire occurs when you are holding a short position on an option that is out of the money. If you are short a put option that is worth $2, closing the position will cost you $2 plus commission. However, letting the option expire will only cost you $2. In this case, no profit is made, but losses were limited.

To learn more, check out our Options Basics Tutorial.

This question was answered by Chizoba Morah.

http://web.streetauthority.com/terms/options/3.asp

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